Onto Innovation Inc (ONTO) 2016 Q3 法說會逐字稿

Good afternoon and welcome to the Nanometrics third-quarter financial results conference call. (Operator Instructions) Please note that this conference call is being recorded today, October 27, 2016.

At this time I would like to turn the call over to your host, Claire McAdams. Please go ahead.

Thank you and good afternoon, everyone. Welcome to the Nanometrics third-quarter 2016 financial results conference call. On today's call are Dr. Timothy Stultz, President and Chief Executive Officer; and Jeffrey Andreson, Chief Financial Officer.

Shortly, Tim will provide a recap of the quarter and our [prospective] looking forward. Then Jeff will discuss our financial results in more detail after which we will open up the call for Q&A.

The press release detailing our financial results was distributed over the wire services shortly after 1 p.m. Pacific this afternoon. The press release and supplemental financial information are also available on our website at www.Nanometrics.com.

Today's conference call contains certain forward-looking statements including but not limited to financial performance and results, including revenue, margins, operating expenses, profitability, and earnings per share. Such statements may be identified by the use of words like believe, expect, and similar expressions that look to forward events or performance.

Although Nanometrics believes that the expectations reflected in the forward-looking statements are reasonable, actual results could differ materially from the expectations due to a variety of factors, including general economic conditions, changes in timing and levels of industry spending, the adoption and competitiveness of our products, industry adoption of new technology and manufacturing processes, customer demand, shift in timing of orders or product shipments, changes in product mix, our ability to successfully realize operating efficiencies and the additional risk factors and cautionary statements set forth in the Company's Form 10-K on file for fiscal year 2015.

Nanometrics disclaims any obligation to update information contained in any forward-looking statements.

During today's call, we will also refer to financial measures not calculated according to generally accepted accounting principles. Please refer to today's press release for an explanation of our reasons for using such non-GAAP measures as well as tables reconciling these measures to our GAAP results.

I will now turn over the call to Tim Stultz. Tim?

Thank you, Claire. Good afternoon, everyone, and thank you for taking the time to join us on our call.

Today I will speak to recent highlights of our business and financial performance as well as industry trends and our business drivers. I will conclude with our guidance for the December quarter.

Following my prepared remarks, Jeff will provide additional details on our financial results after which we will open the lines for Q&A.

Our September quarter results reflect continued revenue growth and outperformance versus the overall wafer fab equipment or WFE market and another quarter of improved financial performance. While 3-D NAND revenues continue to be strong and were once again the largest contributor to our sales volume, we saw a more balanced mix of business across our customer base with significant sequential growth in foundry and DRAM revenues.

Our quarterly and year-to-date results clearly demonstrate the progress we have made against our commitment to improve financial performance across all areas of our business.

In the third quarter, we posted five-year highs in operating profitability, earnings per share, and free cash flow. We also added $22.5 million in cash to the balance sheet. In the first nine months of 2016, revenues increased 12% over the comparable period of 2015. Gross profit grew by 20% and operating profit nearly tripled. Incremental gross profit and incremental operating profit over the same comparable period were 82% and 80% of incremental revenues, respectively.

Free cash flow for the first nine months was 19% of revenues, above our target model. The successful execution of our multiyear strategy to target Key Technology inflection points with an industry-leading process control metrology solutions has resulted in tool of record positions with every leading semiconductor manufacturer across all device sites. It has also been the catalyst for revenue growth, share gains, and overall outperformance versus wafer fab equipment spending.

And while 3-D NAND business has been a major headline for us this year, there is much more to the nano story. Over the last several quarters we have realized significant growth and increased market share in integrated metrology systems as well as good progress in growing our thin films business.

Year-to-date, in both integrated metrology and thin films, we have already exceeded our previous full-year revenue records. We are also executing well against our strategy to increase our value in the fab through technology upgrades, software, and data analytics. And for the full-year we are on track to deliver record high revenues in key areas, including the total memory end market, service, and upgrades.

Fundamental to the ability to gain and sustain share at leading-edge technology nodes is the requirement to continuously develop and offer new products, technologies and systems solutions. To be successful, new product offerings must have a timely intersection with customer roadmaps and address the challenges they face in developing and producing leading-edge devices.

Earlier this year we introduced the Atlas III and IMPULSE+, the newest additions to our flagship OCD product line. In addition, we launched [De Frac 4], the latest upgrade to our OCD modeling and analysis software.

Together these products significantly raise the performance bar for OCD metrology and give our customers powerful new capabilities in process control. Following a successful multitool installation with our launch partner earlier this year, our Atlas IIIs in combination with our De Frac 4 software have already been accepted for production and are being deployed into next generation DRAM high-volume manufacturing.

The successful sign offs of these tools within two quarters of product launch have a solid gross margin performance within the first quarter of revenue recognition are evidence of our improved operational execution, while meeting our customers' aggressive timelines and challenging performance objectives.

In 2017, we will continue to strengthen our market and customer positions by launching several new products, once again tightly aligned to our customers' roadmaps and performance requirements. Over the last few years, technology inflection points such as FinFET transistors and 3-D memory architectures have been key drivers of incremental OCD demand as well as being instrumental in enabling us to win market share with leading-edge customers.

Today, both our 3-D NAND as well as DRAM customers are faced with a new metrology challenge, full characterization of extremely high aspect ratio device vias or channels. In 3-D NAND, there are channel holes with height to width aspect ratios approaching 35 to 1. In DRAM, there are storage capacitors with aspect ratios approaching 50 to 1.

For these 3-D device structures, metrology measurements are far more complex than just heights, widths and depths, which are challenging by themselves. However, in addition to those basic geometric features, our customers need to measure and characterize channel or sidewall tilt, top to bottom asymmetries, irregularities deep within the channel and process induced shifts or feature alterations.

With OCD metrology, using two complementary but uniquely different optical technologies in combination with extremely powerful modeling software, it is possible to provide comprehensive 3-D characterization of these new high aspect ratio features on a nondestructive high-speed in-line platform.

These new applications, along with emerging metrology challenges in alternative memory device architectures are increasing the reliance and demand for leading-edge OCD solutions and now is a leader in all these areas.

Looking forward to 2017, there are a number of important industry trends and planned investment paving the way for another strong year of WFV in general and Nanometrics in particular. We expect significant new project spending by multiple customers in both second and third generation 3-D NAND where we have a very strong market position.

We expect investments for high-volume manufacturing of 1X DRAM to result in a growth year for DRAM spending where the Atlas III has already been accepted and deployed. We expect growth in our foundry business from 10-nanometer capacity spends, HIBM ramping of 7 nanometer and development of 5 nanometer devices. And we expect the increasing role of our thin film metrology, integrated metrology and software and data analytics to further add to our growth story.

As a final note, I want to speak to an important topic we have been addressing for some time now, the increasing importance of advanced process control or ABC. Advanced process control strategies use metrology and data analytics to play an ever-expanding role in accelerating fab ramps and driving yield improvements.

Both process challenges tied to the growing number of process steps and reduced tolerance for process variations at our Company new device architectures. The role of in-line process control, which leverages synergies between automated and integrated platforms, has become increasingly important to our customers.

Notably, the total process tolerance budget is now less than the sum of the controllable budgets for each individual process step. The only way to address this challenge is by using fab light process control strategies across multiple process tools and multiple process steps.

Because we uniquely offer full-featured automated and integrated tools and the software that can tie them together, this is an area of particular strength for nano. Our process control solutions are being deployed fab-wide with the ability to share and leverage data in both feed forward and feedback with protocols, between tools from multiple vendors and across multiple steps.

By doing so, our tools and software solutions are helping our customers reduce process-controlled data latency, accelerate ramps and drive yield improvements. And as a consequence of these trends in our product offerings, nano is playing an unprecedented and increasingly important role in overall fab management and yield performance.

Summing it up, we are continuing to grow our business, improve our financial performance and perform favorably against our business model targets. As evidenced by our fourth-quarter guidance and in combination with our year-to-date results, we fully expect year-to-year revenue growth to once again significantly outperform WFE trends this year. And as we have guided previously, we expect our second-half revenues to be stronger than our first-half results.

Importantly, we remain positive about the ability to continue this trend into 2017, benefiting from industry investments and leading-edge technologies, our strong OCD and growing thin films market positions, our product and technology roadmaps and our commitment to drive and improve operational excellence in all that we do.

With that, our guidance for the December quarter is as follows. Revenues of between $54 million and $59 million and, on a non-GAAP basis, gross margin of 51% to 52%. Operating expenses of $20.8 million to $21.4 million and earnings of $0.22 to $0.31 per share. For the full year, our Q4 guidance represents annual revenue growth of between 15% and 18% over 2015 and a range of $0.97 to $1.06 in earnings per share which is about four times greater than last year's earnings.

I will now turn the call over to Jeff for a detailed review of our financial performance and outlook. Jeff?

Thanks, Tim. Before I begin my comments, I'd like to remind you that a schedule which summarizes GAAP and non-GAAP financial results discussed on this conference call as well as supplemental revenue segment information by product, end market, and geographic region is available in the investor section of our website.

Third-quarter revenues were $58.7 million, an increase of 5% from Q2 and up 29% from Q3 of 2015. Product revenues were $49.6 million, an increase of 5% from Q2 and up 33% from Q3 of 2015. Service revenues of $9.1 million were up 9% from Q2 and increased 7% from the third quarter of 2015.

By end market, the NAND segment which is now predominantly 3-D NAND moderated by about 30% from a record high second quarter to comprise 42% of product sales in Q3. The DRAM and foundry segments each doubled from the second quarter to comprise 23% and 20% of product sales, respectively, in Q3.

Our IDN logic segment was 7% of product sales and all other devices and substrates comprised the remaining 8% of product sales. By product type, total third-quarter revenues were comprised of 60% automated systems, 17% integrated metrology systems, 8% materials characterization systems and the remaining 15% to service. Our 10% customers in the third quarter included SK Hynix at 19%, Intel at 19%, Micron at 15% and TSMC at 10% of total revenues for the quarter.

I'll now discuss the remainder of the P&L, which are non-GAAP measures, unless I identify the measure as GAAP based. These measures exclude the impact of amortization of acquired intangible assets.

Our Q3 gross margin was 52.5%, an increase of 70 basis points from the second quarter. Product gross margin was similar to Q2 at 54% and service gross margin improved to 44%. Product mix had a favorable impact on product gross margin in the third quarter, reflecting a strong level of upgrade sales and the fact that the initial Atlas III recognized as revenue had a negligible effect on our gross margins.

For the fourth quarter, we are forecasting a lower level of upgrade revenue versus Q3 and will be within our target model range of 51% to 52% for this revenue book. Operating expenses of $21.3 million were above our guidance range of $20.6 million to $21.2 million primarily due to a shift of product development program spending into the third quarter.

We are expecting a similar range of operating expenses for the fourth quarter which reflects both a 14-week quarter and an increase in stock compensation expenses as a result of the appreciation in our stock price.

For the full year we continue to expect total operating expenses to be similar to 2015 level. Below that operating line, other income was $149,000 and included a foreign exchange gain of approximately $100,000. Our tax expense for the quarter was $1.3 million or 14% of pretax income. This was lower than expected due to the timing of a favorable adjustment to our US tax and was equivalent to $0.02 per share. We expect our fourth-quarter tax rate will be in the range of 15% to 17%. Net income for the third quarter was $8.3 million or $0.33 per share.

Turning to the balance sheet, cash and investments increased $22.5 million from Q2 and ended the quarter at $118.5 million or about $4.76 per share. Day sales outstanding decreased to 63 days from 87 days in the prior quarter, principally due to the recognition of and collection of our deferred revenue buildings. Excluding the impact of deferred revenues, DSOs for both quarters were similar, in the low 70s.

Our deferred revenue decreased to $17.4 million and mainly consists of Atlas III shipments and other systems requiring customer acceptance for revenue recognition. Inventory decreased $7 million to $43.7 million at the end of the third quarter as we recognized revenue on the deferred systems and shortened our supplier leadtimes.

Cash flow from operations increased to $20.9 million, reflecting the increased profitability concurrent with improvements in our working capital levels. Free cash flow was $20.1 million.

And with that, I will turn the call over to questions. Operator?

(Operator Instructions) Tom Diffely, [D.A.D.]

Good afternoon. I just want to do concentrate a little bit on the memory part of the business for the out year. You talked about how the second and third generations of 3-D NAND were going to be a big driver for you. So curious, with your own product set, what is the opportunity of an upgrade of an existing fab from the first generation to second or third generation or the green fielded a new fab going straight to second or third generation?

This is Tim. Thanks for the call.

Most of the growth that we are projecting in 2017 is equivalent to greenfield fabs or second phase fillouts on existing fabs. If you look at the investments that Samsung and Hynix, Micron, and Toshiba have spoken to, they are still tooling these out with new tools and they are not conversions. And that's going to be the predominant contributor to our 3-D NAND business.

So in that sense, though, is the opportunity -- I assume it's bigger for a new second generation or a new third-generation versus what you initially did for the first generation?

It depends on which -- whether you go to the second or third, when they start stacking it. So the first and second generation it's about the same opportunity for OCD for 10,000 wafer starts. When we get into the areas where they might be stacking them as opposed to just adding layers, then there's incremental demand for the tools. But if you refer to the model that we've got published in our IR presentation, it still holds pretty true to that through the first couple generations.

Okay. And then previously you mentioned on the DRAM that you thought it would start in the fourth quarter. Is that still the case and how much of a recovery do you expect in the out year?

DRAM has been picking up or it picked up for us this quarter. DRAM spending is continuing. We've got three customers out there that are making investments. They are staggered. They are not coincident and we see some first half with one customer and we see some second half with a second customer.

Okay, great. And then finally when you look at the upgrades, how do you internally try to forecast the timing of upgrades? Is it consistent with when new fabs are going through a technology change or what is it that drives the high-margin upgrades business for you?

That's a really good question. Some of it is just the large installed base of tools we have where we can offer increased productivity to existing fabs on older technologies and it's not necessarily just targeted to fab conversions. So we'll go to customers that have 20, 30, 40 of our tools in a given fab and we have a compelling value proposition to upgrade the hardware to maybe give a little more throughput, a little more precision and repeatability and it just improves -- it's a benefit to the existing fab.

At the same time we do have those fabs that are being converted and, in those cases, we go after -- when we know the conversions are occurring, then we go into them with a set of upgrades that support the conversion of the new technology challenges and the cost of ownership objectives. So, it's kind of split.

Okay. Is there a rule of thumb where you can upgrade one or two generations and then you have to get a new tool? Or how does that typically work out?

That's a [plus], so I love that one Tom. I don't know. I've got one customer that's been using the same toolset for seven years as you know and we have provided upgrades on that area.

That's more the exception than the rule. Most of our customers are using through 1 to 2 technology nodes and they are driven to take advantage of the technology advancements so they like the new tools because of a number of new features, capabilities and cost of ownership benefits that are not necessarily upgradable to their older platforms.

Okay, great. Thanks for your time.

Patrick Ho, Stifel Nicolaus.

Tim, as you look at the December quarter, you know you mentioned that you continue to see strength in foundries, DRAM and 3-D NAND. Can you just give a little more color in the mix, relative to 3Q whether there is any changes in, I guess, to the top market segment will be in Q4?

In Q4 versus Q3? (multiple speakers) Is that --?

Yes.

Patrick, I would have a tendency to put a little bit more weight on the foundry DRAM opportunities. You know, as opposed to the 3-D NAND. 3-D NAND will continue to be a reasonable market but there's some strength whole second half of the year on recovery and increased spending both in foundry and DRAM.

Great, that's helpful. And maybe following up on the foundry. As they moved to 10 nanometers and eventually to 7 nanometers, how much do you see opportunities in terms of upgrades versus even new tool buys as they transition from one node to the next? Particularly since some of the leading players have talked about 10/7 being kind of the same node. How do you see that opportunity potentially shaping up for you down the road?

That's another good question. Since that's really customer-specific and we are relatively new in terms of the market share gains we've made on the 14 and 16 nanometer, most of the opportunities for us our new tool opportunities. So when you look at where the investments on the 10/7 is, we don't think 10 is going to be a big node. We think there will be some overlap going into the 7. We think 7 will be extended but in the 10/7 combination, it's really not those fabs. It's mostly new tool opportunities for us.

Great. And final question from me. Some of the inroads that you've made on the integrated metrology side of things, in terms of the business model, given that you've talked about product mix as being one of the key variables for gross margins, how do you see any potential shipped from your automated business to integrated as that grows as a percentage? Does that have any impact on overall gross margins?

I'll give you one answer and then I'll let Jeff put numbers around it but generally we work very hard. When we changed our business model and integrated to be a direct sale to the end-user, we basically increased and restored the gross margin contribution.

So, if you look at our integrated business and our automated tools, and what we've done in both areas, we've done our best to make sure that all of them contribute pretty close to the same level of gross profit to the numbers. Now there is a mix number and, Jeff, you speak to how what you might expect in swings but it's not huge.

It's a very small difference. There is a difference but it's relatively small. And you can have mix impacts both with an integrated versus the automated, depending on the application and the amount of software we sell with it.

But we don't really see as one ramps versus the other [that] they will have a big impact on the gross margin.

I think when you are modeling it, Patrick, the integrated certainly has a much lower ASP but the volume of integrated in a given fab tends to be higher, because of the way they are installed and the attach rate of those tools on, for instance, on polishers and deposition tools. So we get the benefit of higher volume, lower ASP but overall nice contribution to the revenue story.

Great, thank you.

Mark Miller, The Benchmark Company.

The upgrades you are seeing, are they more hardware than software? More shifted towards hardware?

This quarter, it was a relatively strong quarter. There were some software in there but I wouldn't say that it's significantly different than any other quarter. Software always pays a component of it. But a lot of it was hardware this quarter with some conversions we were doing for upgrades.

The hardware was detectors lamps or something else?

I don't know if we'll get to that level of specifics. The hardware that we put in is generally a hardware and software combination that gives a little more performance and in terms of precision repeatability which is -- has got a value to the customer and they go hand-in-hand, Mark. We have software advances but they are tied to the hardware component that leverage the tool's capability.

How much of the upswing in DRAM is due to stronger PC market as opposed to next-gen type chips?

I don't -- I wouldn't tie all the DRAM to the PC market get I think you've got mobile devices that are also having to drive it. Most of the spending and the investments we are seeing are going into the advanced nodes and, as we said, the 1X notes.

Okay. And the DRAM improvements. That's coming from more DRAM per mobile device? Is that's what's driving that because mobile device has slowed down so much in units, at least cell phones.

The reason we are seeing an uptick is that the DRAM investment cycle has been pretty low because of the low spot prices on it. So there's been a -- there was a slowdown in the middle of the year on DRAM investments and now it's a balance between the supply and demand side. And what we are seeing is that both advanced the technology node to deal with the mobile device content and also to provide supply that's starting to be more in balance with the demand, all the DRAM manufacturers are stepping up and putting more money into their fabs and their technologies.

Current expectations are very strong in NAND/bit growth 45%. And there's sort of a growing feeling that with some of the challenges with 3-D flash that we are going to be in a -- certainly not an oversupply in condition -- if we do get into a shortage condition and prices are still staying up for NAND flash, can you see them reverting to you know expanding 2-D type flash, or are you confident they are going to be able to get up to 3-D stuff fairly quickly?

They need the -- I think they are fully committed to the 3-D NAND technology. I don't think anybody is going to try to drop back to the NAND applications. They need the performance and the density.

You've got five major investors. You've got more coming out of China that are looking at it. They are all pushing on the technology nodes and they are pushing to get to the price point crossover with hard disk drives for SSDs.

So I think you're going to see everybody investing. I think this whole idea of supply and demand is a little bit of the model there is -- needs to be reevaluated because it's a price-elastic market, unlike what you see in the end-use markets for the logic devices and DRAM. I think at the right price point, you'll have almost insatiable demand for incremental memory and I think all of the major customers that are developing these and producing them recognize that and have that in their own models.

Just one more. Did you say logic sales were roughly a percent of total sales for logic?

7%. 7%.

7%? Thank you.

Weston Twigg, Pacific Crest Securities.

First, I just -- looking at the December revenue guidance, a lot of the other equipment companies have been having pretty good guidance. I'm surprised that you didn't guide revenue up given the pretty strong demand environment.

I'm wondering if maybe that suggests that you'll have a revenue spike in Q1 or Q2 or something in the first half. Can you maybe give us an idea on the visibility into first-half 2017 based on the current demand trends?

I can't give you specifics, Wes, because as you know we don't guide into the quarter ahead beyond the current quarter. But there is a timing element there.

As you know, our revenue growth is -- for the year -- is greater than WP by a large percentage. Our revenue growth is greater than our competitors who actually, if you look at one of the largest competitors, that had a nice guide up for Q4 came off a down Q3 in the calendar quarter. We have had sequential up guidance.

So some of it is timing. Some of it is where we are tied into the nodes where the developments occur. Some of it is tied to the fact that we have a big push on 3-D NAND as we tool off those fabs and we believe that 2017 is going to be another substantial growth year. We think that investments that we've been speaking to will help us increase our revenues and I don't think that we necessarily see a spike in Q1 but we see continued growth throughout that year.

Okay, that's helpful. The other question I had was just on the tax rate. It's pretty low, especially compared to the model. As we think about the tax rate for 2017, can you help us maybe give us a bracket [plan]?

I mean the tax rate number is low because essentially we've written off our deferred tax asset for the US. And so, basically, you are seeing some -- you are seeing the tax basically on the foreign legal entities but next year, if the tax asset is recovering we are back to more normal rates, it will be around low 30s.

We have to do an analysis if we don't put the tax rate -- tax assets back on the books and it will probably stay in this 15% to 20% range, just depending on the one-time nature of certain things. Does that help?

I think it does help. Thank you.

It's not an easy answer. Sorry.

David Wu, Indaba Global Research.

I got a question for you, Tim. Your revenues have been between $55 million and high 50s since the second quarter of this year and I was wondering next year your revenue should increase but what is going to drive the breakout of that quarterly revenue above $60 million? And Jeff, is it possible to hold your operating expenses flat in kind of 2017 after the performance of calendar 2016?

David, I'll try to answer your first question and I'll let Jeff answer your second question and thanks for calling in.

What's going to drive it is that as you know, we've gained substantial market -- we've had substantial market share gains and solid positions in 3-D NAND which has been a wonderful market for us and we see a lot of -- we see increased spending next year in 3-D NAND over this year, so if you look at the big growth rate and you look at the fabs that have been planned, you look at the total capacity being put in place, we see a lot of opportunity in that robust market. And as the market leader in that space, it's going to support growth.

We've also got the elements of growth coming from the new foundry in DRAM spending that we mentioned earlier in the call. Our software and data analytics business is beginning to grow. Our thin films business which we recently had a record thin film business is starting to become a nice contributor. So if you add new thin-films business, if you add the software and data analytics, if you look at greater investments of 3-D NAND in 2017 versus 2016, then we have a great deal of confidence that it's going to be a growth year for us.

Is the breakout quarter going to be first half or second half of the year? At this point?

David, you can try. I'm not going to give you that much clarity and I probably have to be careful not to call it a breakout quarter. I think that what we are trying to do is trying to have nice, steady incremental growth as best we can paid we've tried and Jeff -- I'll let Jeff speak to the operating expenses. But as you know if you look at the incremental profit and the incremental margin against our revenues, for the year. Our midpoint we're going to be adding something like $30 million in revenues and $20 million in operating profit incremental.

So we've got a robust model and, for us, if we can continue to operate with that kind of flow-through with profitability and putting cash on the balance sheet, I don't think we need a breakout quarter to be a company that's doing a hell of a good job.

David, on operating expense, if you look we essentially have the rate flat for what's going on three years. So as Tim said we look at 2017 as another really good year for us potentially.

So I would expect that we will manage our operating expenses within our business model and you know if you see some incremental growth, you'll probably see some incremental OpEx but we're not talking about any step functions. I think if you look at our model, it grows at a fraction of the revenue growth.

Okay, thank you.

(Operator Instructions) I'm showing no further questions at this time. I would now like to turn the conference back over to Timothy Stultz.

Thank you once again for participating in our call. Special thanks and continued appreciation to our dedicated employees and business partners without whom now would not be such a great company to be part of. With that we conclude our conference call today.

Ladies and gentlemen, this concludes today's conference call. Thank you for your participation and have a wonderful day. You may all disconnect.